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The Zone: making a superannuation future

Michael Short

Chief executive of the Australian Council of Superannuation Investors, Gordon Hagart. Photo: Eddie Jim

[WHO] Gordon Hagart, chief executive of the Australian Council of Superannuation Investors.

[WHAT] Labour owns the capital these days through a massive pool of retirement savings.

[HOW] Boards and executives must sustain companies in the long-term interest of shareholders, rather than seeking quick profits.

One of the greatest battles in post-industrial economic and social history, the conflict between labour and capital over the sharing of profits, is effectively over, at least here in Australia. The massive pool of retirement savings invested through our superannuation sector means labour now owns much capital; the interests of workers and their bosses are aligned as never before.

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There is now more than $1.6 trillion accumulated in superannuation, a lot of which is invested in Australian companies. That is approximately as much as the total value of all the goods and services produced by our economy each year. To give another indication of the heft of the retirement income industry, the total value of shares in Australian companies listed on the stock exchange is about $1.5 trillion.

It's driven by demographics. In response to the looming ageing of the population, which has heightened the need for robust retirement savings, unions traded off some pay rises for employer contributions to superannuation during the 1980s.

The savings pool really began to grow, though, in 1992 when the ALP government of Paul Keating introduced compulsory superannuation. Employers are currently compelled to pay 9.5 per cent of employees' salaries into a superannuation fund. That is set to increase gradually to 13 per cent. Meanwhile, spurred by generous tax concessions, many people divert as much income as they can into superannuation, adding to the overall growth of the retirement savings.

Today's guest in The Zone can be seen as a champion of the millions of us who have superannuation accounts as a result of mandatory superannuation. There are about 11.6 million people employed in Australia.

Gordon Hagart is the chief executive of the Australian Council of Superannuation Investors (ACSI), which effectively is a private watchdog seeking to ensure boards and company executives place shareholders' long-term interests above all else. ACSI advises superannuation funds about investment risks, and closely monitors companies' performance on governance, including the remuneration of executives.

"One element uniting the investors we advise is that there are some issues out there that can affect the value of the investments but that most people in the market systematically ignore. They just don't bother analysing them and they don't bother thinking about them when it comes to valuing assets. And those issues are what we call ESG issues. ESG is environmental, social and governance issues."

"What we do is very classically driven by the desire to make as much money as possible for as little risk as possible. All we're trying to do is acknowledge that the world is a complex place and that the time horizons that are meaningful for our members and their members – that is, real people and pensioners and superannuants – is much longer than the time horizon that the markets work on.

"So we're not trying to redefine capitalism, we're just saying 'continue to try to serve shareholders, but just make a much better job of it'."

Scottish-born Hagart is relatively new in the top job at ACSI, but he has long experience in financial markets, to which he came via an unorthodox and circuitous route. Until late last year, he was the chief of environmental, social and governance risk management at the $100-billion Future Fund, a superannuation fund for commonwealth government employees.

He was trained in geophysics – a highly analytical field, but one ostensibly unrelated to managing investment risks. After his master's degree, his work included modelling the probability of earthquakes. But he decided on a change and swapped seismograph spreadsheets for ones that modelled corporate uncertainties.

He became an investment banker, doing company mergers and acquisitions, in London. Initially he found the new role interesting and challenging, but his enthusiasm waned.

"That was not what I wanted to expend all my time and emotion on for the rest of my life and I moved to the United Nations after a few years and I thought, well, I would like to work on environmental issues, social issues, issues of justice, human rights, environmental protection. But I should probably for my own sake try to leverage what I know and what I can do.''

"I came to the conclusion that there was maybe some interesting nexus between how companies perform and how investors perform and how those entities related to the natural environment and to society and how they were governed, what kind of wrapper went around them and controlled them. That seemed to me a pretty intuitive proposition and therefore I was surprised to find that there was very, very little work done in capital markets or in private corporations on that notion."

A video statement by Hagart and the full transcript of our discussion, can be found at theage.com.au/federal-politics/the-zone. He will be online for an hour from midday to respond to questions and comments, which can be submitted from this morning.

"When people talked about environmental issues it was always in the context of doing the right thing ethically or morally – you know, be a good guy – rather than it is actually just an enlightened way to serve your shareholders." One way of looking at this is there can be no prosperous high streets without healthy backstreets.

There is a deficit of this enlightened self-interest, an ACSI report released only weeks ago showed. It said a "disappointing" 40-plus per cent of Australia's biggest 200 companies still rate in the lowest two categories of ACSI's annual review of sustainability disclosure.

ACSI said: "The review is based on the premise that environmental, social and governance risks can have a significant impact on the long-term performance of companies. Therefore, thorough disclosure of information regarding their performance in these areas, broadly referred to as sustainability risks, is integral to quality investment decision-making."

There is some good news, though. While more than 40 per cent of the top 200 companies rated in the categories 'Basic' and 'No Reporting', almost as big a chunk now rate in the top two categories, 'Comprehensive' and 'Detailed'.

The level and structure of chief executive officer remuneration is a controversial and crucial corporate issue. It is a key area of transparency, a way in which shareholders and potential investors can assess the governance rigour of a board of directors.

Many in the community understandably view executive salaries as obscenely inflated. In the US, for example, the average chief executive officer salary is 200 times higher than the average worker's wage. Here, that ratio is 70-to-one.

Following the 2007-08 global financial and economic crisis, the growth of CEO remuneration in Australia has eased, but there remain concerns that bonuses are inappropriately high and calibrated to short-term profits.

Boards have a responsibility to recruit competent CEOs and to reward them for creating sustainable profits, rather than maximising short-term returns to speculators. Hagart argues that boards' primary responsibility is to long-term shareholders.

"A good structure for remuneration, to our minds, is one that is aligned to the interests of the shareholder, so that you are incentivising things that are good for you – the creation of value over the long term. We want one that rewards genuine attributable performance ...

"If all that has happened is the price of nickel has doubled and the price of the share has doubled, that was not really as a result of the genius of the CEO; they probably should not be paid for that. If you take two nickel companies side-by-side which have experienced the same spot price change but one has doubled in value and the other has quadrupled in value, because of the management skills of the latter, then probably there is some justification in that latter case of a reward through variable pay.''

In the mid-1800s, another Scotsman, essayist Thomas Carlyle, attributed most important developments to heroic individuals – an idea referred to as 'the great man theory of history'. In contemporary US corporate life, this has translated into the stratospherically-elevated status and salaries of chief executives – think of Microsoft's Bill Gates, Oracle's Larry Ellison, Apple's Steve Jobs or General Electric's Jeff Immelt.

Hagart believes we have, with a few exceptions, been spared such silliness here. He says Australia, where shareholders' interests, rather than, say, those of employees or customers, are the main focus of boards and the managers they oversee, is relatively well-served by its corporate sector.

And a fundamental reason for this is that the long-term interest of labour and capital are so inextricably linked.

"There are people that come and go, but essentially there is a community of long-term investors – and in Australia the superannuation fund community is a huge part of that – that have bought a long time ago a share of Australia Proprietary Limited and currently own that and will always own that.''

8 comments

Gordon, many people really do feel chief executives are paid more than they deserve - that is, more than their performance justifies. The article says the average remuneration of a CEO of a listed company is as much as 70 times the average wage. How can that be fair?

Commenter

EdiS

Date and time

August 04, 2014, 8:48PM

Hi EdiS. Thanks for your question.

You’re absolutely right that many people find executive remuneration obscene (per Michael) or unfair. The question of the level at which pay becomes unfair is really challenging – one that has always troubled ethicists. It’s very difficult to set a fixed ceiling on what is fair pay for a role (either an absolute number or a multiple of the average employee’s pay) without being arbitrary or normative. Not least across multiple sectors and regions. The shareholders that ACSI advises therefore tend to reshape the question in terms of their mandate to maximise risk-adjusted returns over the long term. The question therefore becomes: what pay >structure< is most likely to maximise value creation over the long term, through attracting and retaining talented management and incentivising them appropriately? Implicitly, that places trust in the market to set the absolute levels of pay for a role, assuming that the market is transparent and overseen by the providers of capital. That’s not to say that the absolute quantum of pay is never of interest to investors. If a 10-person company in the outer reaches of the ASX300 was intending on matching the CEO pay levels of an ASX50 company, that would be pretty unlikely to get shareholder approval. Likewise, if the aggregate pay of the executives is so big that it introduces material risk to the company’s earnings or cash flow, clearly that would be an issue. Again, net returns to the folks that are footing the bill – the shareholders – are the frame of reference. The fact that shareholders and boards in Australia talk frequently about this issue (including legitimate community concerns around absolute levels) has allowed us to avoid, in relative terms at least, some of the excesses of markets like the US.

Commenter

Gordon Hagart

Date and time

August 05, 2014, 5:39PM

I read this morning that the three main stars of The Big Bang Theory had allegedly signed new contracts worth $1m each per half hour episode. A lot of money? Clearly. Obscene? Unfair? Possibly. But possibly also a wise commercial decision by Warner Bros. Television in terms of retaining perceived talent, to the benefit of the shareholders of Time Warner (who are ultimately mostly regular people who are members of pension funds or own mutual funds). It’s an extreme case of supply meeting demand and a market being made. The same dilemmas face sports clubs when they set salaries and bonuses for their star players. These clubs are also businesses, with commercial imperatives and duties towards their owners. A few are even publicly listed (A.S. Roma, Manchester United, etc.), and therefore part owned by, and notionally run to create value for, broad swathes of the public. To the extent that those businesses are indeed being run to create value for their owners, then the question with star players is identical to the question in respect of executives (or any employee) – what pay level maximises the net return to the owner >over the long term<? And what pay structure maximises the chance that the individual will act in the interest of the owner, rather than his/her own interest (again, over the long term)?

Commenter

Gordon Hagart

Date and time

August 05, 2014, 5:40PM

Enlightened companies get that their human resources at all levels can be a huge part of the overall value of their organisation, and that the value proposition they offer to their employees is not just the financial component. It also comes through fair and transparent behaviour by both counterparties, creating a safe, enabling work environment, training and development opportunities, running an organisation with clear values and ethics that people are proud to work for, and so on. Such conditions are the basis for motivated, loyal, productive employees. And that’s good for shareholders.

Commenter

Gordon Hagart

Date and time

August 05, 2014, 5:42PM

Dear Michael,

At the beginning of your article in The Age you wrote that"the conflict between labour and capital over the sharing of profits is effectively over, at least in Australia".In this respect, is Australia different to otherwise similar countries?

Does Gordon Hagart think that there is, or always has been, a trend to increasing wealth disparity in capitalist countries?

I would like to hear what he has to say about the effect of inequality of income and wealth on the health and stability of societies.

Thank you

Michael

Commenter

Michael

Date and time

August 05, 2014, 11:14AM

Thanks for your questions. I guess I’d begin by saying that I’m not sure that I’d agree the conflict alluded to is over, here or elsewhere. But I do share the view that it has a different hue when you consider that (a) much of the capital used by listed companies ultimately belongs to large numbers of regular people saving through pension funds and other investment vehicles and (b) the representatives of those people – institutional asset owners (super funds, et al.) – are active in pushing management towards outcomes that are value-adding over the long term, and sustainable in all senses of the word. This dynamic exists in many parts of the world, but I think that in Australia we are lucky to have capital markets with an abundance of smart, long-term investors like super funds and sovereign wealth funds, who take their duties to their members and the long-term time frame that I keep coming back very seriously and accordingly drive the outcomes I describe above. Additionally (in part because of the above), we have a community of company directors that is mostly accessible to those funds and willing to engage in constructive conversations about the common interest in shareholder value, and how to get there through, inter alia, good corporate governance and sound management of environmental and social risks and opportunities. Again, this provides a bit of a buffer against some of the extreme disparities seen in other countries.

Commenter

Gordon Hagart

Date and time

August 05, 2014, 5:47PM

Your second question would be better answered by economists, politicians and other policy makers. Michael made reference to Thomas Piketty’s recent work on this issue in the interview, which has reignited this debate (a very healthy development). From my point of view income/wealth inequality is absolutely an interesting and important macro risk for long-term investors to analyse. It’s the kind of issue that falls nicely under the definition of ESG issues – issues that have a nexus to environmental, social or governance concerns, and are financially material for long-term investors, but are under-researched because of that long-term time horizon and poor data and analytical frameworks. So the inequality issue is definitely one we would flag to our members, and one which we would raise with company directors as part of our assessment of how they navigate such risks to and opportunities for their businesses (social risks in this case).

Commenter

Gordon Hagart

Date and time

August 05, 2014, 5:48PM

A final point I’d make is that, although one might traditionally think that institutional investors are part of the problem in terms of wealth inequality, the converse is potentially true. Again it’s about who ultimately owns the capital. In a country like Australia a large percentage of the population is in that ownership community thanks to our advanced superannuation system. Ensuring that we have high-quality super funds is crucial to maximising investment outcomes for those savers, which I would think could be a countervailing force to wealth inequality. In a self-serving way I’d say that one of the hallmarks of the quality and member focus of many Australian super funds is the work they do collaboratively on ESG risks and opportunities.